Maintain NEUTRAL. It was a weak 1QCY18 reporting season for developers as margin issues plagued earnings, resulting in the fourth consecutive quarter of downward earnings revisions. We also saw more misses in terms of headline sales, although we note that the big-boys were mainly on track largely due to their bigger marketing presence and wider market reach. Sales outlook remains unexciting on looming margin risks with our universe’s total sales/earnings expected trajectory of -9%/-9% YoY in FY18E/FY19E and +3%/+11% YoY in FY19E/FY20E. In fact, it will be harder to predict sales momentum this year as most developers are actively clearing inventories. Our universe’s; (i) average unbilled sales are at 1.1 years or at slight improvement from last quarter (0.9 years), and (ii) average net gearing is at 0.23x which is healthy. Valuations are almost at trough levels with many trading at their historical low PBVs or record high RNAV discounts – we think this could give way to potential M&As or even privatisation plays. The sentiment on the sector is likely to be subdued because of the absence of catalysts, oversupply and affordability issues, while policy clarity will likely be made known during Budget-2019 announcement. However, we think that bashed-down big boys with deep value, firmer earnings trajectories in the nearer term and decent balance sheet, are tactical options and under this investment case, we prefer UEMS (OP; TP: RM0.970) followed by MRCB (OP; TP: RM0.700).

Worse than last quarter. Out of 13 developers under coverage, 46% missed expectations (MAHSING, UOADEV, IOIPG, CRESNDO, MRCB, AMVERTON). Only 1 stock (HUAYANG) exceeded expectations while the rest were within to broadly within. This is worse than last quarter whereby 31% of coverage disappointed while 31% positively surprised. The main issue faced this quarter were margin compressions arising from higher overheads and lower product margin mix.

More misses with headline sales with 38% of our coverage were behind in terms of meeting targets (IOIPG, MRCB, SUNSURIA, AMVERTON, MAGNA) while the rest were in-line to broadly in-line. It is a deterioration compared to last quarter where only 23% missed targets and 15% exceeded targets. Many developers held back new launches running up to GE-14 as buyers were holding back given the uncertainties. Also, this year, most developers are looking to clear inventories and take-up rates of these inventories can be sporadic or unpredictable. We are observing very heavy marketing campaigns by most developers (e.g. rebates/discounts, freebies, ‘deferred payments’ on differential sums for shortfalls seen in many buyers’ margin of finance). Thus, there is still possibility that developers could play catch-up with sales in coming quarters. Noticeably, the big-boys were mainly on track with sales targets largely due to their stronger marketing ability and wider market reach, while the smaller players saw weaker sales performances.

Fourth consecutive quarter of downward earnings adjustment. We reduced earnings estimates for 54% of our coverage (MAHSING, UOADEV, IOIPG, CRESNDO, MRCB, SUNSURIA, AMVERTON, MAGNA) by 9-37% and only revised up earnings for UEMS (21-55%). This is also poorer than last quarter where we cut earnings for 46% of our universe while only raising estimates for 32% of our coverage. During the 1QCY18 reporting season, most of our CALLs were maintained as we had already rebased our valuations to lower levels prior to results (5/4/18 sector strategy). However, we did reduce TPs for 38% of our coverage (UOADEV, HUAYANG, MRCB, SUNSURIA, AMVERTON) while the rest were kept unchanged. We note that the reductions in TPs are mainly for small-mid cap players which are observing more volatility in earnings compared to the big-boys. Last quarter we; (i) downgraded 15% of our CALLs while the rest was kept unchanged, and (ii) reduced and raised TPs for 15% each.

Unexciting sales outlook coupled with earnings risks due to margin compressions. Our universe’s total sales/earnings expected trajectory is -9%/-9% YoY in FY18E/FY19E and +3%/+11% YoY in FY19E/FY20E. Our universe’s; (i) average unbilled sales are at 1.1 years or at slight improvement from last quarter (0.9 years), (ii) average net gearing is at 0.23x or a healthy level. The reduction of GST to zero will help offer some relief for developers’ margins and/or allow them to pass on savings to buyers to improve affordability. However, since most developers’ product pipelines are largely residential and GST savings will only be felt in the newer launches, impact on margins may not be immediately significant. As a result, we do not think this will be seen as a major catalyst for the sector. Additionally, we note that developers are giving discounts/rebates/freebies and are extensively using agents to clear inventories, which will also have negative implications on margins; nonetheless, we reckon that it is better for developers to clear inventories to unlock capital rather than retaining margins at this juncture.

Source: Kenanga Research - 5 Jun 2018